(The following story by Robert Wright appeared on The Australian website on April 12.)
SYDNEY, Australia — When the southern Californian ports and railroad yards handling Asian container imports were overwhelmed by a sudden surge in volumes in the summer and autumn of 2004, there was a telling difference between the yards of the area’s two main rail operators.
At those of Union Pacific, which runs North America’s largest track network, chaos was nearly complete, with customers’ containers often left for many days before a train could be found to take them to distribution centres and retailers in the eastern US. At the yards of Burlington Northern Santa Fe, which has the second biggest network, trains ran much more smoothly.
BNSF’s superior handling of the 2004 crisis resulted from an investment program that had been criticised by many investors as over-expensive, but which meant the company had more double-track lines, sidings and other facilities than Union Pacific at the key moment.
It is the kind of superior management that many observers believe has encouraged Warren Buffett, the world’s most famous investor, to make BNSF the biggest of several investments in North America’s once unfashionable railroad sector.
It emerged last weekend that Mr Buffett had invested $US3 billion ($3.6 billion) to buy a 10.9 per cent stake in BNSF, based in Fort Worth, Texas.
The 2004 traffic surge, which has continued at a less dramatic rate since then as the global outsourcing boom has continued, also illustrates why BNSF is not the only attractive investment in the sector.
Alongside BNSF, Mr Buffett has confirmed that he has invested $US1.4 billion in two other rail operators – presumably others among the seven large operators known as the Class I Railroads, although he has not identified them.
The railroads have benefited from increasing competitiveness against trucking, which for decades ate away at their freight business. Trucks – which consume more fuel for a given cargo – have been hit more than rail operators by oil prices. Truck operators have also suffered more from the tightness of supply in the US labour market.
However, the surge in volumes of container traffic – known as intermodal traffic – following the boom in manufacturing outsourcing to Asia has been the most important growth factor.
“The change in intermodal traffic from being marginal to being the star performer is really the single story that has been driving the surge in investor interest,” said railroad analyst Anthony Hatch.
According to Henry Posner, a US-based international railroad investor, BNSF’s achievement has been to make the highly competitive intermodal market profitable – a sign of its generally excellent management. Mr Buffett is known to target strong management teams for his investments.
“Everybody talks about intermodal as being the big growth area and having the big potential, and that’s true,” Mr Posner said. “But it’s also by definition a low-margin business, because every trucker is your competition and every other railroad is also in that market.”
However, the most important change for railroads – and Mr Buffett – may be a less obvious one. According to one analyst, the past few months have for the first time in many decades seen three Class I railroads – BNSF, Canadian National and Norfolk Southern – boost their returns on investment to above their cost of capital. CSX and Union Pacific, should meet the measure soon. The change should mean investment in growth should become far easier.